Abstract

The recent global financial crisis has raised important questions about governments’ “too big to fail” policies and their potential impact on bank risk-taking. It is now clear that certain banks in almost all countries are considered to be too big to fail and will receive taxpayer-funded bailouts if failure appears imminent. An important question that arises is whether larger banks, that enjoy this status, have in fact taken on more risk than their smaller counterparts who face much more credible threats of wind-up or bankruptcy should they get into financial difficulty.
This study confirms that larger banks take on higher levels of risk than smaller ones and this finding persists when returns are measured before interest and taxes. The higher risk levels are driven by the lower capital to assets ratios and higher variances in return on assets of the larger banks. There is some evidence that large banks also generate higher returns on assets. The findings will be of interest to regulators and central banks since they can potentially contribute to better allocation of supervisory resources and more appropriate intervention strategies, such as requiring these riskier large banks to hold higher levels of capital or to pay additional taxes as has been proposed by the International Monetary Fund. This study appears to be the first using this methodology on a sample of banks that ranges from the very smallest to the very largest and includes both publicly-traded and privately-owned institutions.